Peg the export price index: A proposed monetary regime for small countries

This paper proposes a new monetary regime for small open economies: Peg the Export Price Index (PEPI). An earlier version, Peg the Export Price (PEP), applied to countries that were specialized in the production of a particular agricultural or mineral commodity. PEP proposed fixing the price of the single commodity in terms of local currency. It has been objected that PEP is inappropriate for countries where diversification of exports is an issue. For such countries the modified version, PEPI, proposes fixing the price of a comprehensive index of export prices. In either version, one advantage is that the currency depreciates automatically when the world market for the country's exports deteriorates. This is an advantage that floating rates also promise, but deliver only partially, as calculations here show. The other advantage of PEPI is that the currency does not appreciate when the world price of the country's imports goes up. The candidate for nominal anchor that is currently most popular, targeting the CPI, has this unfortunate property if literally interpreted, as calculations here show. Overall, the advantages of PEPI can be summed up by the observation that, unlike other proposed nominal anchors, it is relatively robust with respect to terms of trade shocks.